This is your biggest enemy while investing

(Jul 6, 2013)

In this issue:
» Will gold plunge to US$600?
» Will Air Asia be another Air India?
» Can gas price hike solve India's power problems?
» Obstacles for new entrants in banking space
» ...and more!

00:00

What are the key factors that you consider while investing in any stock? Undoubtedly fundamentals, valuations and management quality would rank high amongst host of other variables. Basically these three key factors rule your decision to buy or sell. While this seems to be pretty much true on paper the reality is quite different.

The truth is that most of our investment decisions are governed by fear! And fear arises from our emotions about how we perceive others will react to a given situation. Let us explain how this tenet rules our sell decisions.

Generally people intend to sell when fundamentals deteriorate. That's one angle to it. However, the actual action of selling culminates when fear grips us of losses we may incur by not selling.

Take the example of a stock which is on a declining trend. While fundamentals may not warrant a decline from certain level the stock may still go on to reach new lows. The reason is people start selling out of fear. A person who is scared sells assuming that others are also scared. This brings the stock price below its fundamental value. In short, fear results in selling too soon. And this happens because an individual bases his decision to sell by perceiving other people's state of mind on the stock.

Now let us see how fear rules our buying decisions. Head back straight to 2008 when the credit crisis was at its peak. Most stocks were trading at dirt cheap valuations then. Yet there were very few people who stuck their neck out to buy. Why? The answer is again fear. And this happened because their thinking was based on the perceived situation in the market place. Outside environment created a sense of panic which restricted individuals to buy. But those who overcame fear made a pot of gold out of their investments.

Thus, it can be seen that FEAR makes us take decisions which are not favourable over the long term. It is an emotional hindrance that investor has to overcome while investing. However, overcoming fear does not mean you have to be contrarian. It means executing the decision if you feel the process you followed to arrive at any decision (buy or sell) is right. As long as the process is right there are high chances that the final outcome/reward will also be huge.

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India's fondness for gold is well known. The demand for yellow metal has increased so much in recent times that government had to take steps to curb gold imports in order to take care of widening current account deficit (CAD) and depreciating rupee.

As today's chart shows the demand of gold increased substantially in 2010. Increasing gold demand started putting pressure on Indian rupee and CAD. Hence, government started intervening by increasing the import duty on gold. Recently, RBI also made it mandatory that any import of gold could be made with only 100% cash margin. This is likely to put further restriction on gold imports.

It can be seen that post 2010 the demand for gold has been on a downward trend. And with government and RBI taking steps to curb gold imports we won't be surprised if the total demand in 2013 turns out to be lower than 864 tonnes as witnessed in 2012.

Data source: World Gold Council & Rediff

01:55

Gold touched another low yesterday. It is now at its 34-month low level. So, can we see a rebound from here? Or the yellow metal is doomed and is destined to go even lower. If a gentleman named Barry Ritholz is to be believed, gold will indeed see a temporary rebound. However, what he has predicted next is not good news for gold lovers. He believes that there was a ten year uptrend in gold between 2001 and 2011. And with the current correction, the trend has clearly been broken. He therefore anticipates gold to go down further after a temporary rebound. How much down? Well, the correction could be as much as a gut wrenching 50%! In other words, a US$ 600 per ounce gold cannot be ruled out.

Mr Ritholz also took pot shots at gold bugs arguing that all the things that they are worried about like hyperinflation, dollar going to hell and fiat currency doom are simply false. Well, we don't think so. They are of course not visible right now but we would love to see how long the game lasts. All the problems the world was facing few years back have hardly gone away. They have just been suppressed under the garb of liquidity. And when the liquidity vanishes, gold will be the last man standing we believe. Thus, the direction the gold price will head into is not south but north according to us.

02:15

The aviation sector in India has been fraught with issues. High taxes, costs, competition are just some of them. As a result of these issues, several airlines have shut shop. But the one big issue that has plagued the sector is politics. It is politics that led to the epic bailout of Air India using tax payer's money. It is also politics that led to the troubles of Air India in the first place but that's another issue. Therefore it was not very surprising that foreign airlines did not come flocking to the Indian shores when FDI in aviation was approved last year. But despite these issues, Air Asia did decide to enter India in partnership with Tatas.

Its CEO, Mr Tony Fernandes is confident that he can run an airline successfully in India. His strategies are simple. Run a low cost airline. Chart new aviation routes rather than flying to high traffic but high cost sectors like Delhi and Mumbai. And aggressively negotiate with state governments to reduce taxes on fuel. As such it sounds like a good plan but we will have to wait and see if Mr Fernandes is successful or not.

02:55

Just recently, the government came out with a formula that is likely to double gas prices from next April to around US$ 8.40 per million British thermal units (mmBtu). The basis on which this formula has been worked out has sparked off much debate. But the idea is to spur investments in the gas sector in the country.

But will this move solve India's power problems? Not really. Power shortages have been the bane of the Indian economy for quite some time now. The country continues to face blackouts. And as per an article in Reuters, a third of the 1.2 bn population has no access to electricity. This has then prevented the country from taking its economic growth to the next level. And whether this gas price hike will really solve the ills afflicting the sector remains to be seen.

For starters, rise in gas prices means that power companies would look to pass on this hike to distribution companies in the form of higher electricity charges. But the problem is that power distribution companies are already mired in considerable debt. And so they will not be able to bear the burden of higher electricity prices. This means that they may very well halt supplies. The government has recognized the issues faced by the distribution companies. It has even hinted that if these companies cannot cough up higher charges, the government might have to subsidize them. But that only compounds the problem further as higher subsidies will only add on to the fiscal burden of the government and defeat the very purpose of the reforms in the gas sector. Thus, it will be interesting to see how the government manages to deal with this quandary going ahead.

03:40

The much awaited licenses for new players in Indian banking sector is unlikely to usher in an era of superior profits for the incumbent and new banks. In fact as reported by Business Standard, finding a foothold in India's fragmented banking system will at best be a challenge. Fitch believes that the smaller players will find it rather difficult to live up to RBI's expectations. The central bank's objective of financial inclusion would make heavy demands on profitability and capital. Thus besides the mandate of SLR and CRR (cash reserve ratio), new entities will have to bear the cost of rural presence. Profitability, if any, would come at a much later stage. The established NBFCs, are however, relatively better placed to switch to bank status. Nevertheless, unfamiliar risks and additional regulatory hurdles will not make the going easy. We strongly believe that it would not be feasible for every applicant of bank license to turn into a profitable and healthy bank. The onus of ensuring that only the most suitable ones enter the sector therefore lies on RBI.

04:15

Global stock markets have been volatile for the past several weeks on worries about a credit crunch in China and, more long term, fretting about how assets will perform should the US Federal Reserve begin to taper its US $85bn a month bond purchases. Chinese interbank lending rates have returned to normal levels, easing some concerns about the health of the world's second-biggest economy.

US stocks moved higher in a shortened trading week. Positive economic data appeared to drive stocks higher. Stocks jumped after the US Labor Department reported that employers had added 195,000 jobs in June, slightly above consensus expectations. US markets were up by 1.5% during the week.

In Europe, two heavyweight central banks (BOE and ECB) have stepped forward to apply some monetary balm by making clear interest rates will stay at unusually low levels for a long time. The dovish signals from the Bank of England and European Central Bank have boosted stocks and clobbered the currencies for which they are responsible. The stock markets in UK posted the sharpest gains of 2.6%.

The Indian equity markets closed the week in the green with the shares in the FMCG space leading the gains. The Indian stock markets were up by 0.5% during the week. The Chinese market was also up by 1.4% over the week. The Japanese market registered strong gains and closed the week up 4.6%.

Data source: Yahoo finance

04:50

Weekend investing mantra

Have the courage of your knowledge and experience. If you have formed a conclusion from the facts and if you know your judgment is sound, act on it - even though others may hesitate or differ. You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right - Benjamin Graham

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With Govt. finally deciding to strictly regulate the import of Gold. The speculation in this commodity should come under control and this should also gradually bring down it's price at the international market and in effect also bring the price at local level. This likelihood seems inevitable due to the fact Indians are the second or may be third largest importers in the world, of this yellow metal.

Personally, I ignore the reasons by not selling taking cognizance of past experience allowing full impact of reason.This time will open up reasons of fall and take decision to sell.This will turn in loss.

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